The 411 on 529’s

Matt: 00:01

It's another reason that 529s are a great account, I’m Matt Robison joined by Mike Morton my co-host on financial life planning. I, I'm okay, the titles okay.

Mike: 00:14

It's okay.

Matt: 00:15

I think I liked the name of the podcast just fine.

Mike: 00:18

I expanded it. I expanded it Matt. It's now financial life planning for busy parents. How do you like that actually?

Matt: 00:25

It’s very descriptive. I love your Snakes on a Plane naming model, there you go. Going to give you exactly what you know what you're going to get.

Mike: 00:32

You know what you're going to get you know who it's for. And you're searching on a plane. Yeah, hopefully, if you're searching and you found this is the first time you listen to because it now says for busy parents and you're like, that's me. Yeah, that's Matt and I as well and we're here with you.

Matt: 00:47

For people who might be suspecting, wait there, this is a bit like Matt knew that Mike had written no, I did not know that. That's great, though. Like it's like that old timey radio feel. It's hey, buddy.

Mike: 01:01

Hey, hey, we need some of those like sounds in the background? How can we get some of that with the old time radio like the clip-clop have you walking into town clip clop clip clop clip clop. Can we do more of that in the back?

Matt: 01:14

Are you trying to bank two coconuts together because I'm riding on horseback?

Mike: 01:19

Exactly, in the Caribbean.

Matt: 01:21

What we need is old timey ads, it's like Johnson's doorknobs works. Alright, here we go. Mike, you want to talk about why the 529, another reason the five to nine is a great account. I've got 529s, I need them because I'm a busy parent we're part of our brand now. So just remind us for a second people probably know what the 529s are but maybe not. But yeah, what's, what's the 529? What's it for?

Mike: 01:48

Yeah, so first, I want to say what where the meat of the episode is really this new, the secure 2.0 act added yet another reason why the 529 is great. They added the ability to take money from your 529 and put it into a Roth IRA. So you don't have to just use it for education, which is what a 529 is for.

Matt: 02:06

Your name for the episode is absolutely terrible. Because what you're saying, what you're saying is one of the great features of 529 died is that you can get out of it. That's terrible marketing.

Mike: 02:16

Wait, oh, yeah, no, you have to keep the money, you can't get out of it, you get the money out of the 529 and into your Roth IRA. It's so great.

Matt: 02:25

Okay, it's still tax free, you're actually confusing me here. I know, let's start with, let's start with today, 529 is good on its own right?

Mike: 02:35

Absolutely love 529’s, 529’s is named after section 529 of some book of codes by somebody in the government and somewhere in that, and it's for education expenses, education savings, for qualified education expenses, so that it's a special account type. Alright, there's all different kinds of accounts, you can open, you can open up a savings account, a checking account, you can open up a brokerage account, you can open up Roth, IRAs, 401K's all this stuff, this is a 529 account, you can open one of these up, and you can put money into it. And the money you put you contribute money just transfer money usually no real special clauses when you put money into it. But then it grows tax free, you can invest the money in the 529 education account, it grows tax free for many years, as long as it's in there. And then when you want to withdraw the money, you use it for qualified education expenses, then it's tax free. So all of that earnings and growth is all tax free. And so people typically man, obviously you and I had these the way we typically use them is you have a child, a young child, and you're like, Hey, I'm going to get started with saving for them, you open up a 529, you're the owner, the beneficiary is going to be your child because that's who the expenses will eventually be for. And you could just put in a couple of thousand bucks because it's going to grow over 15-20 years, put in a couple thousand bucks, maybe you set up recurring contributions every year if it’s auto invested. And then by the time you are pre saving for when they're in college you use it for qualified education expenses.

Matt: 04:11

That's actually they're super easy. I think we're not going to belabor a lot of details on 529s. We've done actually more than one show on 529s, just go back into the financial life planning really for busy parents too. Okay. Go back into Mike Morton's podcast, you'll find it. It's an easy Google search. But yeah, I mean, they're super easy to do and I really like it. I got to say, you know, one of the features you talked about is that in each state you can get your own state 529. So this is one of the wrinkles, it's like way down to the weeds and you gave a pretty good guide in our previous episode walking through how you might select which state you want on how to pick it, but then it's like any other account. They make it really user friendly these days. So I have three kids, I said three 529s, you can even these days, it's a lovely little hack that they'll give you a little code because of course, they want people putting money on institutions. So you can get this, you can get this link that you can share with family members. And it's, hey, you're looking for a grandson birthday present, put money into their 529s. So very straightforward. All very great. So now, you what, let me just remind people, we're just a tiny, tiny bit of detail. So when you say qualified education expenses, you do mean, there's a pretty broad range of things that qualify. So like, one of the complaints people get is like, they get the college bill. And it's like, hold on a second, this is the list price, but then there's all the extras that they throw in room and board and food and all that. But most of that stuff qualifies as well. And so this really is an all in savings plan for education.

Mike: 05:51

That's right, qualified education expenses covers a lot, not just the tuition, but also room and board. Also textbooks, computers, internet access, special equipment, depending on the school you go to, and then even if you're off campus, you can actually use some of the money for that living expenses, either the rent or even for food, up to what the room aboard water cost. And so it's really a ton and ton of expenses and then let me also tell you to the 529s, they're great when they first started, awesome for all these qualified education expenses. And it's been expanded recently what you can use it for. So those are qualified education expenses, you can use it for a four year private college, two year colleges, trade schools, you're going to culinary school, but you could use it for that kind of stuff. So it's really I mean, it's supposed to be for education, you know, broadly speaking, and then over the recent years, it's been expanded. So the tax cuts Jobs Act, added K through 12, you can use some of the money even before you get to the post secondary education. And then the secure act added more the ability that you could use, pay off student loans up to $10,000. So there's really a lot of 529s can be used for.

Matt: 07:08

I didn't know that student loan one. That's a good one, and you also, I'll just make this a teaser, because I want people to listen to the more detailed episode that we did about this, again, just search back in the feed for the 529s. But there is this cool little hack where you can funnel your current costs for K through 12. Education through your 529s and you can in certain circumstances get a meaningful state tax deduction. There's a lot of details and provisos on that, but you walk through all of that so that's a really good one.

Mike: 07:42

Yeah, absolutely. If you have current K through 12, check your state, see if you can get a tax deduction. And check that out. It's a really nice little thing you can do.

Matt: 07:50

All right. So now I finally figured out now that we've gotten through the preliminaries here, I figured out what your game is Morton. For people who are somewhat new to the podcast, let me tell you something. Alright, Mike's wife should be suspicious because Mike is having a hot and heavy affair with Roth IRAs. Man, you love yourself some Roth IRAs, you go down to your basement at night, and you have a whole like group of Roth IRAs, and you'd like look at them. It's true. So what you really mean with this episode is, you know what's so great. So when you say, here's another reason to love 529s that's what gets you back to Roth IRAs. About this, this act 2.0 thing that gets you to your heart throat.

Mike: 08:40

Yes, Roth IRA. Thanks to my favorite Roth IRA. Although I do have a very special place for the health savings account as well as you know, Matt, right triple tax benefits so that’s in there never pay taxes ever.

Matt: 08:52

So if health savings account and Roth IRA were togethe and your the bachelor, okay, who are you handing the rose to?

Mike: 09:01

I'm gonna go you know, it's funny, even though the health savings account has tripled tax benefits, I'm going with the Roth IRA. It's so wonderful and great. I love Roth IRAs. It's true. You're right, you got it.

Matt: 09:15

It actually, it is disturbing. All right. Yeah, we're gonna do a fun episode at some point where we do like an NCAA March Madness.

Mike: 09:24

Yes. We'll put them out head to head.

Matt: 09:28

Like a Cinderella in there.

Mike: 09:29

Yeah. Okay. Love it.

Matt: 09:31

What would be your early pick? Let's say something, let's say there was like a 15 seed that was up again.

Mike: 09:38

I'll tell you right now. I got it. The 457 deferred comp.

Matt: 09:42

Oh, I don’t even know what that is. Super. Yeah. It's like one of these schools you only hear about a tournament type like Southern Illinois. Oh man. My gosh. This is so good. My brother in law always picks Southern Illinois because they are abbreviated to So Ill, I love it. All right, secure act. Alright, secure act.

Mike: 10:05

Let's go so secure Act 2.0 added yet another reason, you know expanding the use of the 529, so it makes the 529 even better, Congress added the ability to transfer money from your 529 into a Roth IRA. Okay? So if you happen to be, one of the big concerns with 529s is overfunding. Having leftover money in your 529, how much should I put in? I've got a kid who's got a 529, like should I put in $10,000 or $20,000 or $1,000 a year like how much you put in there? Because then the next question is, how much is college going to cost? Right? And so it's bunch of unknown assumptions, all the money doesn't matter what you put in there.

Matt: 10:46

We talked about this, this was one of my pain points. I seriously I was stressed about this. What if I overflowed my 529? And you're like, really, really this is your problem? It's like, Hey, Mike, what if I'm too rich and good looking? You know, like, I'm really concerned about this. And you're like, I assure you that you will not overflow. But people do worry about this. I actually do worry

Mike: 11:07

No, and it's true. And my first comment to everybody is, you'll end up with money you didn't expect to have, which is never a problem. So you were expecting to spend this money on education because you made smart choices at the time using assumptions. We talked about it, and you put in this amount, and then you end up with extra because whatever happens in the future, it's not a bad problem. So that's my first comment extra money you weren't expecting to have. So it's not bad. But here Congress has added another use for that money. Okay, so here's how it works. And it's pretty complicated. Okay, but the bottom line is 529 money extra, 529 money leftover 529 money can be funneled into a Roth IRA. Now, details are still coming out. This is not even implemented today, I'll tell you why. Because you got to wait 15 years. That's the first thing. Alright, your 529 has to be open for 15 years before you can even do this. So that's the first caveat to all this. And again, this was just passed very recently. So it's not I don't even think you can click on it and do it today. I'm not sure institutions where your 529 account is that you could even do this tomorrow. All right, still kind of rolling out. So, actually from the Secure 2.0 act. There's other things, the 401k rules, there's some updates and that stuff hasn't been implemented either by the institutions that actually have the accounts have to make sure they do it the right way. So they're still working through the technical details.

Matt: 12:30

So but the bottom line is this alleviates it alleviates that stress point, right? It's what you just, that's exactly right. You actually don't need to worry about this because you're giving people an escape hatch. That's exactly why I don't like to term calling it a backdoor because we already have backdoor. Yeah, right. But you have an escape hatch. So it says the bottom line for people is this actually sneakily is for all my teasing. This sneakily is a feature of 529s because it does have that like you have a get out of too much money free card.

Mike: 13:04

more reasons to put in more money into a 529 and the great reason for putting money into the 529 is it grows tax free. And then the whole point is after 15, 20, 30 years. It's growing tax free. Hopefully you can get it out tax free. Now if you had overfunded it that might be hard to do. But we can talk about strategies. But this is another way that Congress has said yeah, here's another way you can get the money tax free put it into the Roth IRA. So here's how it works. Matt, you have a five to nine. You've got kids, you have three of them. Let's just pick one for your youngest child. Okay, ready. So here's our so just generically, your last child, first two children go to school, you use all the money in the 529s, like, they're definitely going to college, last child is so special, gets lots of scholarships which you can take money out for scholarships, by the way, you end up with an extra $20,000 in your last child's name, who is Rick, your last child's name is Rick. So Rick has extra $20,000 in the 529 to launch his career. So you've had the 529 for more than15 years. So that's one thing I mentioned, you have to have your 529, open for 15 years. You can only use contributions that have been in there longer than five years. All right. So Matt's already made this contributions, it's 15 years in the future, and the money has been in there but you can't just contribute money and then roll it over that next year. It's got to be in there for at least five years. At that point, Rick is the beneficiary of your 529, there's $20,000 in it, and you can transfer some of that money into Rick's Roth IRA. Okay, so each year you can transfer some of the $20,000 into Rick's Roth IRA from the 529 into the Roth IRA. That's the whole goal. All right now, how much can you do? Oh, go ahead, Matt.

Matt: 14:58

Well, let me ask let me ask this, we've done several episodes, I would say, on the Roth IRA, but remind me, just in case I forgot, the IRA is like the 529, it grows tax free.

Mike: 15:14

Yeah. So the Roth IRA exactly right, it grows tax free inside of the account. And then when you pull the money out, it's tax free, there are some rules there, you have to be 59 and a half to be pulling out the money. Otherwise, there could be some penalties. There's some other little rules there. But that's the general gist. So it's for retirement, the money going into the Roth IRA goes in after tax. Okay, so you've already paid taxes on the money going in the Roth IRA, so it grows tax free, take it out tax free. Remember, you pay taxes once except for for your HSA, you always pay taxes once the government wants their taxes. So the Roth IRA, you pay them upfront. The same with the 529, you'll notice the contributions, you didn't get a special tax deduction, other state tax deductions, but you've already paid federal taxes on the money going into 529, it grows tax free, take it out tax free. That's why you can transfer to Roth. You've already paid federal taxes on it and the money grows tax free, when you take it out for qualified expenses, it's tax free, when you take it out, when in retirement, the Roth IRA is tax free. Are you ready to create your ideal lifestyle? Let's discover what's most important to you and design a plan to have more of that in your life. Go to meet Mike morton.com. All one word meet Mike morton.com.

Matt: 16:31

So that's the key point here is that it's the same function. It's just you thought you were going to spend it on education, you had some leftover, now it goes to retirement. And so if what you say my son's name is Rick.

Mike: 16:46

That's the first thing I thought

Matt: 16:48

Makes me think of silver spoons like yeah, Rick? Well, yeah. Rick, it is, Rick. I'm going to go downstairs and call him Rick.

Mike: 16:57

This is going to be great.

Matt: 16:58

So Rick, you've talked about this a lot. Again, something I urge people to go back in the feed and check out because establishing a Roth IRA early for your kids is super great. And so this is, Rick has got to be feeling awesome about this. Because first I'm saving for his college. And then if there's money left over, and guess what, you're gonna get this amazing, awesome gift in 40 years of a ton of money.

Mike: 17:25

Yeah, exactly. So it's been because you're contributing to Rick's 529 when he was very young, and it's grown. So it's already doubled, tripled over 15 years, you didn't end up using it. And now you're transferring it to the Roth IRA, where it's just going to continue to compound so you can do so I said, you had to do it over multiple years. Okay, you could do $35,000 total, from the 529 to Rick's IRA. So that's a lifetime limit. $35,000 can go from a 529 into the Roth IRA. Now, each year, you're limited by the Roth IRA rules. So Roth IRA rules, there's an annual limit, and you have to have earnings. Okay, so this year, it's $6,500. So you could only do if you're doing it this year, for Rick, he's aged 25, you could only do $6,500 of the $35,000 limit. Okay, so you're limited yearly, by the Roth IRA contribution limits, you're also limited, Rick couldn't do both a Roth IRA contribution and the transfer of the 529. Okay, so you have $6,500 limit for 2023. If you're transferring $6,500, from the 529, that's it. That's your $6,500. If Rick contributes 2000 of his own money, you can only do $4,500. Okay, you're limited by the yearly contribution limit, which is $6,500. All right, total, and then he's got to have eligible earnings. Alright, so that's Roth IRA rules, Rick has to have eligible earnings in this year of more than $6,500 to do the total $6,500 contribution. So again, those are Roth IRA rules, but they apply to this conversion.

Matt: 19:06

I see this, you know, what this is all prompting for me is, I think I'm beginning to understand what you do a little bit better. Because there are, this is such an important caveat that we can't, we probably can’t repeat it enough because people get sick of it eventually. But it's worth repeating that what you do is distinct from what people who work for institutions that might also be selling these products do, right, you're not like some you don't work for UPS going to pick on someone here Fidelity. And so you don't have any vested interest whatsoever. As matter of fact, you have the opposite in saying you should have this kind of account, you should open this, you should do this kind of this kind of an investment. And in fact, what you do is I listened to all of the complication involved. There's so much you need to track over time. If you need to, it's not just about getting on a plan, but then you need to keep track of it okay? Right now we're executing a multi-year transfer from one account to another. This requires planning, and then there's the planning that goes in years before, which is, hey, you need to, for one thing, have a five to nine account for another thing, you need to have a Roth IRA. And then you need to make sure that you've anyway, it's, this actually makes entire sense to me. So is that is that basically what you do is, you get this whole picture and you think about with everyone's needs, and everyone's like, desires and goals, and etc, you throw it all in the mix, and you figure out how to like an incredibly complicated this is, this is hard.

Mike: 20:47

Well, it isn't, it isn't. But you've exactly described it, right? That's exactly what I do is knowing all these little rules and the details, and this is just on 529s, and just with this Roth IRA conversion, it's what makes sense for you. So I'd be thinking, Oh, Matt, yeah, you've got three kids, here's the level of your 529s that's looking pretty good. Or we could add more like, whatever the strategies are that we want to customize for you. It's throwing it all into the pot. And then boiling up, here's the most important strategies that apply today, either get started with a Roth IRA get started with a 529 or wait on this thing for five years. But yeah, that's what we do is work on what's the right strategy for you.

Matt: 21:27

So let me ask you this, does this new escape hatch rule for 529s change your waterfall? And what I mean by that is we talked episodes ago about you've got a certain amount of money, what's your order of operations for the first fund, this second fund that third, you know, then, whatever money you have left? You know, now that you have this, get out of jail free card for 529s, has that moved things in the waterfall for you?

Mike: 21:56

Yeah, that's a really great question. I would say yes. In terms of not so much the waterfall because I like that. I know exactly what episode you're talking about. And I liked that way of thinking through everything. But in terms of over funding, the 529 is something I always talk about with every client. And it's always about I'm worried about over funding. This escape hatch is another reason for me to feel confident to say, you know what, instead of oftentimes I take 50% Hey, let's say this is college. Let's pre save about half of it. That way, we're pretty sure we're not going to be overfunded. I might boost that up a little bit and say, you know, what, if you're maybe it's 65-75% and that's just a starting point, it's custom for everybody. Some people are like, no, I want to have all that pre save, great, throw it in there. Otherwise people are like, I can only save $500 a year, great throw in $500 a year, like whatever it is. But this will give me more leeway to say, you know what? Yeah, if you've got some extra savings and education is really important to you, then we can be a little more aggressive with putting the money in the 529, because we have more options on what to do with it.

Matt: 23:03

You know, if I heard you, you said, there's this $35,000 lifetime cap details still being worked out yada, yada. So there is a possibility that if you really overshoot, you could still have some money left over? What happens then?

Mike: 23:18

Yeah, absolutely. So this goes back to the conversation I have with clients all day today, which is the first problem, it's money you are expecting to have spent, that now is just in your pocket. Never a bad problem. So worst case, that happens as you're paying taxes… so the worst thing happens is you're paying taxes on it plus a 10% penalty. So knowing perfect knowledge from 20 years ago, yeah, we could have avoided the 10% penalty. But we had no idea what the assumptions to make at that time, who made the best decision at the time.

Matt: 23:50

So worst case scenario someone's been saving for 20 years, and it's been growing tax free. When they pay the taxes and the 10% penalty. They've also been having that compounded growth tax free. Does it kind of come out in the wash?

Mike: 24:05

No, no, because you pay the 10% penalty on all the growth so you pay the taxes on all the growth at ordinary income rates. So yeah, it's kind of a 10% penalty, but that's the worst case. What you can do now we had this new $35,000, so boom, that's like a lot, you know, that you can get out of there over time. But the other best things to do with it is just to roll it over to other family members. Okay, so you can rollover the beneficiary. Oh, Rick, you didn't use all his money, but I've gotten nieces and nephews and cousins and grandkids you can leave it in there. Let it keep compounding for Rick and it gets to his $20,000 grows to $40-80,000. He starts having kids boom, you got $80,000 that you can transfer 529 to 529 for his three kids, or whatever it is. So you can use it for grandkids or you can use it on yourself, Matt. Matt, you could go back to culinary school and spend the money tax free to go to culinary school I heard that story someone went to Marine Diving school in the Caribbean. Yeah, a week long Marine learning how to scuba dive qualified education expense.

Matt: 25:10

I assure you that my family believes that I should go to cooking college. Exactly. I cook most of the dinners, and yes, that would be a great idea. No one wants to see me Marine Diving.

Mike: 25:22

You might want to go to the Caribbean for a week and learn how to scuba dive. But my point is, you know, you do not I do not like the ocean. Because you forgot that you get the point. So you can use it. Many people just roll it over nieces, nephews, saving for grandkids, let it keep compounding or spend it on yourself. Those are very typical. But now you have again, another escape hatch, you can just get it into a Roth IRA, so that's great.

Matt: 25:47

I love the idea of it. Yeah, I could roll it to myself, but I kind of love the idea that it like just becomes this floating fund, especially for eventual grandkids. Like, you know, I mean, this is a real, this is something that comes up with like grandparents, they want to support their grandkids education. Eventually, we were talking several episodes back about trying to plan for your decline, you know, trying to plan for your later years, this is going to happen, you may not be thinking about this. Now, if you're like me and Mike, and you're in that sandwich generation, right, and you're currently at the point where you've got young kids, your kids are not in college yet. So you're not even thinking about grandkids or like you still got them in the house. You're going to eventually if you're lucky enough to live that long. You're gonna think about this. This is a future worry and it's the opposite of that aphorism. Why borrow trouble? How about like pre-funding, getting rid of your trouble? I actually love this idea that there's this other 529 escape hatch that like, yeah, I could become a grandparent fund, and you're going to want one.

Mike: 26:50

Yeah, they called the 529, a poor man's dynasty trust. For that reason, you can put money in there and just let it compound and grow and use it for future generations.

Matt: 27:00

That is absolutely amazing. That is like you dealt that one from the bottom of the deck. Alright, so anything else we need to know here? I mean, it does sound like, look, there's still some details, bells and whistles to be worked out. But fundamentally, what people need to know right now is what?

Mike: 27:20

Yeah, that the you can be more aggressive with funding your 529 account has more great uses. It has been expanded. That's it. Let me also, yeah, let me also just tease a couple of little pro tips just for the people out there that are really interested in this? Or how can you really maximize some of these strategies? Because that's the other thing we think about Matt is like, how could I use the rules that Congress the IRS has provided me and try to get around them or try to use them to my advantage, you know, and so that's like the backdoor Roth IRA, which we've talked about, it's like one of those, oh, I can use these rules and do this thing. So here's a couple of ideas. One is that even if you don't have kids, you could be opening a 529, you're the owner, you're the beneficiary and putting money into it. Why would you want to debt, well, if you have extra savings, it grows tax free. So rather than save $10,000 In your brokerage account, save $10,000 in a 529 account, let it grow tax free, all right, and brokerage account is not growing tax free, eventually, so you never have kids, okay? In 15 years, you can now start transferring that to your Roth IRA. Never use it for qualified education expenses, but today, you put in $10,000 or $15,000, it grows tax free for 15 years, never have kids don't have education expenses, but you can transfer it to the Roth IRA. So it's a way of getting more tax free growth earlier in your career. Or say you're young and you might have kids in the future, you can open the 529 now. Start putting money in there and in the future 5, 10, 15 years, you can change of beneficiary to your kids. Or you can start funding Roth IRAs. It's more flexibility so while you're younger in your career, and maybe you have a little more extra income Matt and I know we got three kids, there's no extra income anywhere now expenses, just balloon. Okay, so maybe when you're younger and you have a little bit more ability to save you can chuck stuff into a 529 when you get older and you have less ability to save now you have tax regrowth in there that you have more things you can do with it.

Matt: 29:24

Wow, this you know what, you kind of took it full circle because I have been convinced that these are indeed features of 529s and not just another excuse.

Mike: 29:36

Yeah, one more account type. I like your I like your brackets, though. We have to definitely do that. That would be hilarious.

Matt: 29:43

Alright. On that note, let's wrap it up. Alright, so for Mike Morton, I’m Matt Robison and we'll see you next time on I don't know, is it still gonna have the same next name next times!

Mike: 29:53

Find out next week. It's your favorite Thanks, Matt. It's always a pleasure being here. Thanks for joining us on financial planning for entrepreneurs. If you liked what you heard, please subscribe to and rate the podcast on Apple, iTunes, Google Play Spotify or wherever you get your podcasts. You can connect with me at LinkedIn, or Morton financial advice.com. I'd love to get your feedback. If you have a comment or question please email me at financial planning . Until next time, thanks for tuning in. This recording is for informational purposes only and should not be considered for investment advice. Opinions expressed as our have the date of recording such opinions are subject to change. We do not guarantee the accuracy or completeness of the data presented here.